The Fund, by Rob Copeland

The Fund: Ray Dalio, Bridgewater Associates, and the Unraveling of a Wall Street Legend is a tell-all book about hedge fund king, Ray Dalio and his mammoth firm, Bridgewater Associates, which sports a long list of institutional clients. If the reviews are any indication, the corporate culture has been a toxic, Orwell-meets-Torquemada brew of mutual backstabbing and personal criticism, which after a hot start has recently been yielding meh investment performance.

This post isn’t directly about either Dalio or Bridgewater. It’s about the less-than-ideal financial situation of underfunded defined benefit pension providers (meaning traditional pensions that pay out a fixed portion of an employee’s salary, with inflation adjustments, in retirement until the employee’s death–as opposed to a 401k that pays out a one-time lump sum). Most private companies have long since shifted to 401ks. It’s mostly governments that have this problem. And as I see it, it’s this issue that has led to the flowering of the hedge fund business over the last couple of decades.

To be clear, I haven’t read The Fund, and I don’t intend to. I have read a substantial amount of what the prolific Mr. Dalio has written about economics and financial markets. I find it kind of like the sound and fury of Mohamed El-Erian, only with smaller words.

the problem Bridgewater addresses

CalPERS, the California Public Employees Retirement System, is the largest public defined benefit pension provider in the US, with about $440 billion under management. A lot of money, but if financial news reports are correct, it’s still only about 3/4 of what would be needed to pay the value in today’s money of those promised future benefits. To be fully funded, meaning to have enough today to be confident it can pay every participant on retirement, CalPERS would need to have an extra $150 billion under management today. And even that’s assuming that stocks and bonds perk along, making on average inflation plus a little more, until current employees start collecting their pensions.

What to do? Two choices–go to the state legislature and ask it for more money, which would be tantamount to CalPERS executives submitting their resignations (lots of recent turnover, anyway), or to look for investment firms that deal in more exotic products than publicly traded stocks and bonds, and which are willing to promise high enough returns to start closing the gap. The first is a non-starter. The second means hedge funds and private equity.

If I understand Bridgewater, its big sales idea has been risk parity. In its simplest form, the risk parity argument is a kind of name-calling: just owning bonds is bad; they’re a drag on investment performance because they are a low-risk–therefore, low return–asset class. But one can fix this deficiency in the riskiness (and therefore the rewardiness) of one’s bond holdings by buying lots of them on margin (sort of what, in effect, Silicon Valley Bank did, oly without the threat of a run on the bank). During the long period of declining interest rates that started in the early 1980s, this has been a winning strategy. And from the CalPERS point of view, hedge funds provide an aura of respectability for what is at the end of the day a highly speculative strategy.

Unfortunately, it doesn’t work any more. And all the bells and whistles that hedge funds have touted to justify high fees–corporate culture, secret investment insights, proprietary algorithms…–don’t make much (any?) difference. Hard to know what happens next.

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